What is theta gang? Simply put, these are options trading strategies that capitalize on the fact that the prices of options decay over time. Instead of trying to predict if a stock will go up or down, you simply play the time game– collecting premium which turns to profit as time goes by, then rinsing and repeating.
The strategies you could employ to take advantage of theta can really be endless, but I’m going to focus on 3 popular ones that have a high probability of closing in the green and are relatively simple to understand.
This guide will assume you at least know the basics of calls and puts, which should be the bare minimum requirement of anyone trying theta gang strategies. If you need help with that I created an Options for Beginners guide that really breaks down the basics of options contracts without getting too overly technical.
Here are the 3 popular theta gang strategies I’ll cover [Click to Skip Ahead]:
The first two theta strategies are great for beginners and seasoned traders alike because your max loss is limited and you know exactly what that max loss would be. Yet at the same time, you can profit from these trades if either A) the stock moves in the direction you like, or B) enough time has passed and time decay has worked its magic.
These strategies are called the put credit spread and call credit spread. I’ll start with the put credit spread first because that’s generally preferred if you are bullish on the market or stock.
Put Credit Spread
The concept behind a put credit spread, or even a credit spread in general, is that you are selling an option with added protection.
The nuts and bolts for this strategy:
- Sell a naked put
- Buy a cheaper put
So for a put credit spread, you are just selling a put while also buying a protective put to limit your downside. You are selling 1 put while also buying 1 cheaper put… and your profit is the difference between these two. The extra premium that is left after buying your cheaper protective put is your maximum profit.
You’d generally sell a put if you think the stock is going to go up, and because the put you are selling is at a higher premium (because of the higher strike price) than the put you are buying, this is a strategy you’d implement if you are bullish.
Here’s a quick profit/ loss calculation on selling a naked put, using a favorite meme stock like Tesla (I would NEVER recommend selling any options on an overvalued stock like Tesla, unless you’re a masochist or think “stonks always go up”).
A website like this one is a really great tool for visualizing your profit and loss potential on all strategies involving selling theta, and I highly recommend using it at least when you’re starting out.
Potential Theta Gang Mistakes
Here’s some mistakes that could be made with a put credit spread (and with all theta gang plays):
1. Making the spread too small
If you pick strike prices on the puts that are too close together, you’ll get hardly any profit for the capital you are risking. To avoid this, I’d recommend estimating the yield of your credit spread based on how much capital you’re risking AND how long your capital is tied up (the expiry date). If it’s too small a yield, either don’t take the trade, buy a cheaper put, or sell a more expensive put.
2. Setting your protective put too low
If you pick a protective put that is so far out of the money that only a “black swan” event would provide you any sort of protection, well you’re risking a lot more downside risk and getting yourself into selling a naked put territory. In fact, I’d argue at that point you’re just throwing your money away on the protection (like if the underlying stock needs to drop 20% or something ridiculous). You can be aggressive when it comes to setting your credit spread, but don’t be too greedy.
Just remember the old adage: Bulls make money, bears make money, (theta gang makes money), but pigs get slaughtered…
3. Not setting a profit target
This is something I’ve picked up from the Theta Gang spokesperson himself and am starting to implement more with all of my options trading. When you have a profit target of say, 50%, you’re able to capitalize on either the swings of the stock and/or time decay—and once that profit is realized you can free up capital for another trade.
As shared from another member from the Theta Gang website, and I don’t want to get too detailed here, but essentially there’s gamma risk and tail end risk that can increase after you’ve hit your profit target… and so why greatly increase risk to double your money (from 50% to 100%) when you can just take the 50% and start anew without those risks.
I think as it relates to put credit spreads in particular the 50% profit target seems to be a really good one, and one that’s been working for some of the members on the Theta Gang site throughout the “tail end” of 2019.
4. Not doing Due Diligence on the stock
This should go without saying, but I’m shocked by how little emphasis is put on the analysis on the underlying stock throughout many options guides online (or even published books on the subject!). It’s almost thought as an after thought, but should be the 1st step in the analysis.
If you don’t have a fundamental reason to be bullish on a stock based on real, financial numbers found in the income statement and balance sheet, then you have no business selling options on any of those stocks.
5. Not checking volume
Liquidity is always something you should consider when trading options, and especially when trading theta gang spreads. If you’re setting profit targets but trading options with low volume, then don’t expect your trades to be filled when trying to exit. Option chains post the volume for a contract that day, and so check to make sure that there is decent activity before entering the trade if you’re expecting to get out to take profits off the table later.
Moving On (and more quickly…)
That about sums up a basic explanation on the put credit spread, and the call credit spread is basically the same thing but on the call side, with a few minor important details. I hope you’re not too intimated by the breadth of this section to continue on to the rest of the 3 theta gang strategies, but I promise they’re not as intensive.
This one had a lot to cover because it’s such a common strategy for trading theta, and it’s very powerful if used correctly. You’ll find that the 5 mistakes I listed above really apply to all 5 of the strategies on this post, and so I won’t have to harp on them too much again.
Call Credit Spread
This is a spread where you are bearish instead of bullish, and so you sell a call instead of a put. Selling a naked call can be very dangerous because your potential downside is infinite if the stock runs up, and so that’s why this call credit spread includes a protective call to limit that downside risk.
The nuts and bolts of the strategy:
- Sell a naked call
- Buy a cheaper call
Similar to the put credit spread, the trader here wins if the stock remains flat. Being a bearish strategy, you also win if the stock goes down. In either case (down or even), you essentially keep your premium and that’s your max gain (if the sold call expires worthless).
Like the put credit spread, you can choose your downside limit by where you set your protective call– too much protection means small profits, and too little protection allows you to keep more of the short call premium.
Also like the put credit spread, this strategy has 2 additional potential pitfalls: getting greedy and not setting a profit target (and getting wiped out by gamma), or not doing due diligence on a stock and getting crushed the wrong way (in this case, thinking bearish on a stock that’s actually a great company with great catalysts moving forward).
Quick example:
Short Put / “The Wheel”
This one is my favorite theta gang strategy, and especially because I put on these trades on stocks I’m willing to buy and hold anyways. which takes out much of the downside risk– because I’m willing to hold even through a bearish period (remember stocks go up over the long term).
I’ve talked before about how selling puts (aka doing a short put), especially when selling cash covered puts, doesn’t have to be a risky trade, but in this section I’ll specially cover how the wheel makes short puts even better.
The nuts and bolts:
- Sell an OTM put (cash covered preferred)
- Sell covered calls if assigned
Let’s be clear here. Selling naked puts all on its own can be a very risky endeavor depending on how you’re managing the position. Selling a put exposes you to 100% downside risk. In theory, a stock could crash 15% and you’d experience that entire loss. It’s somewhat padded from the premium you receive, but other after that point you take all that loss.
Since most traders (good ones too, I’ll add) tend to limit losses as a principle, that means that losses like these will be locked in. And while you might be thinking that this is a once in a while type of thing, it’s the stocks that are more prone to these moves that will have all of the great premiums to collect anyways (in general).
What makes this strategy not as risky, and much more appealing, is the “wheel” part of the trade.
Remember the key that I mentioned at the top: you employ the wheel on stocks you’re willing to own for the long term. So if you sell a put that gets assigned, you have to buy that stock, often at a loss. Where the wheel comes in is that after assignment, you turn around and sell a covered call to get out without a loss.
As long as your strike price for the covered call you sell is the same as the short put you got assigned on, then the combination of those two trades is essentially zero. But you collected premium on both sides, and that would be your profit.
Remember that we’re talking about the “worst case” scenario here, where your short put gets assigned. What you’ll probably experience instead are short puts that expire worthless or can be bought back later at a profit, and probably can expect at least 70% win rate with this (especially in a bull market).
OTM options, statistically, expire more than they don’t, and so that plus a wheel management strategy makes this theta gang trade very, very appealing.
One more point about downside risk, since I’m a risk-averse value investor at heart:
What can tend to happen when you get assigned on a short put is that the stock will have fallen very far, and so the premiums for covered calls to “break even” could be smaller than normal (since the price fell already).
I have 2 strategies that I use to combat this:
(1) I’ll wait for a decent “up” day before I sell my covered call [note: remember that the ratio for up/down days in the stock market is close to 50-50, so that down day(s) that caused your put to be assigned will likely bounce back at some point (at least a little)]
(2) The more the stock has fallen, the longer the duration of the covered call that I’ll sell. [note: remember that option prices increase the more days there are to expiration, and that’s called options time decay].
Conclusion
In all of these strategies, you are selling theta. That’s what makes them “theta gang”.
As long as the stock doesn’t have extreme moves over the duration that you sell these options, you’ll generally make a profit on them.
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Whatever you do, just remember this one thing:
These strategies can be optimized to limit risk and maximize reward, but at the end of the day there are stocks (and companies) underneath this complexity of options. You could have the smartest options strategy in the world and still have losing trades because you are wrong on the stocks you trade.
So really concentrate on analyzing these businesses, and really hone your ability to identify when a business is in trouble, and when its financials are healthy.
